THE HIGH COURT OF DELHI AT NEW DELHI
% Judgment delivered on: 30.07.2014
+ W.P.(C) 1648/2013 & CM NO.3105/2013
ZAHEER MAURITIUS ..... Petitioner
versus
DIRECTOR OF INCOME TAX
(INTERNATIONAL TAXATION)-II ..... Respondent
Advocates who appeared in this case:
For the Petitioner : Mr Percy Pardiwala, Sr. Advocate Ms Rashmi
Chopra and Ms Vriti Anand, Advocates.
For the Respondent : Mr Sanjeev Sabharwal, Sr. Standing
Counsel with Mr Ruchir Bhatia, Jr.
Standing Counsel.
CORAM:
HON'BLE MR. JUSTICE S. RAVINDRA BHAT
HON'BLE MR. JUSTICE VIBHU BAKHRU
JUDGMENT
VIBHU BAKHRU, J
1. The writ petitioner under Article 226/227 of the Constitution of
India, is a company incorporated under the laws of Mauritius, challenges a
ruling dated 21.03.2012 (hereinafter referred to as the `impugned ruling') of
the Authority for Advance Ruling, (hereinafter referred to as `AAR') in
A.A.R. No.1048 of 2011. By the impugned ruling, the AAR held that the
entire gains on the sale of equity shares and Compulsorily Convertible
Debentures (CCDs) held by the petitioner are not exempt from income tax
in India by virtue of the Double Taxation Avoidance Convention
(hereinafter referred to as `DTAA') with Mauritius and that the gains
W.P.(C) 1648/2013 Page 1 of 25
arising on the sale of CCDs are interest within the meaning of Section
2(28A) of the Income Tax Act, 1961 (hereinafter referred to as `the Act')
and Article 11 of the DTAC and are taxable as such.
2. Brief facts of the case are that Vatika Limited (hereinafter referred to
as `Vatika') is an Indian company and is inter alia engaged in the business
of developing and dealing in real estate. Vatika is the owner of a contiguous
tract of land admeasuring 6.881 acres or 10,00,000 sq. ft situated in village
Badshahpur Tehsil, Gurgaon (hereinafter referred to as the `Land'), which
has been reserved for being developed as a cyber park, to be used for
software development activities and IT enabled services as per the
provisions of Notification No. CCP (NCR)/GDP-III/2001/1555 dated
30.07.2001 as amended from time to time. SH Tech Park Developers
Private Limited (hereinafter referred to as the `JV Company') is an Indian
Company and was incorporated on 04.07.2007 as a 100% subsidiary of
Vatika.
3. The petitioner is a company incorporated under the laws of Mauritius
and is a tax resident of Mauritius and is inter alia engaged in the business
of investment into Indian companies engaged in construction and
development business in India. The petitioner entered into a Securities
Subscription Agreement dated 11.08.2007 (hereinafter referred to as `SSA')
and a Shareholder's Agreement dated 11.08.2007 (hereinafter referred to as
`SHA') with Vatika and the JV Company. As per the SSA, the petitioner
agreed to acquire 35% ownership interest in the JV Company by making a
total investment of `100 crores in five tranches. The petitioner agreed to
subscribe to 46,307 equity shares having a par value of `10/- each and
W.P.(C) 1648/2013 Page 2 of 25
88,25,85,590 zero percent CCDs having a par value of `1/- each in a
planned and phased manner. The SHA recorded the terms of the
relationship between the petitioner, Vatika and the JV Company, their inter
se rights and obligations including matters relating to transfer of equity
shares and the management and operation of the JV Company. The said
agreement also provided for a call option given to Vatika by the petitioner
to acquire all the aforementioned securities during the call period and
likewise, a put option given by Vatika to the petitioner to sell to Vatika all
the aforementioned securities during the determined period.
4. Vatika and the JV Company executed a Development Rights
Agreement dated 06.11.2007 (hereinafter referred to as `DRA' ) in terms of
which Vatika transferred the exclusive development rights, entitlements
and interest in the Land to the JV Company for development of the Land,
with the right to retain the sale proceeds thereof exclusively.
5. On 08.04.2010, Vatika partly exercised the call option and purchased
22,924 equity shares and 43,69,24,490 CCDs from the petitioner for a total
consideration of `80 crores. Subsequently, the petitioner transferred further
equity shares and CCDs to Vatika. The AAR noted that the Balance Sheet
of Vatika for the year 2010-11 indicates that Vatika had acquired the entire
CCDs subscribed to by the petitioner during the Financial Year 2010-11,
and the petitioner was left with only 23,383 equity shares of the JV
Company.
6. On 12.05.2010, the petitioner filed an application under Section 197
of the Act before the Income Tax Officer requesting for a `nil' withholding
W.P.(C) 1648/2013 Page 3 of 25
tax certificate to receive the total consideration from Vatika for transfer of
equity shares and CCDs without deduction of tax. The Income Tax Officer
by order dated 12.09.2010, held that the entire gain on the transfer of equity
shares and CCDs would be treated as interest and tax at the rate of 20%
(plus surcharge and cess) should be withheld on the same.
7. Thereafter, on 16.02.2011, the Petitioner filed an application before
the AAR for advance ruling on the question:-
"Whether on the facts stated in the application and in law gains
arising to the Applicant, being a tax resident of Mauritius on
sale of equity shares and Compulsorily Convertible Debentures
(CCDs) held by the Applicant in SH Tech Park Developers
Private Limited, an Indian Company are exempt from capital
gains tax in India under Article 13(4) of Double Taxation
Avoidance Agreement between India and Mauritius
(`DTAA')?"
8. By the impugned ruling dated 21.03.2012, the AAR held as follows:
"We, accordingly, answer the question that the entire gains
arising to the applicant on the sale of equity shares and CCDs
are not exempt from capital gain tax in India under DTAC with
Mauritius. The gains arising on the sale of CCDs being interest
within the meaning of Section 2(28A) of the Act and Article 11
of the DTAC and are taxable as such."
9. The learned counsel appearing for the petitioner submitted that the
AAR had erred in passing the impugned ruling and holding that the amount
of gains received/receivable by the petitioner resulting from transfer of the
investments held by the petitioner in the JV company, was interest under
Section 2(28A) of the Act. It was submitted that the AAR erred in not
appreciating that there was no debtor and borrower relation between Vatika
and the petitioner. The CCDs were held as a capital assets by the petitioner
W.P.(C) 1648/2013 Page 4 of 25
and the transfer of the said investment was a transfer of a capital asset and
any gains arising therefrom were liable to be treated as capital gains.
Consequently, such gains could not be subjected to income tax in India in
terms of the DTAA between India and Mauritius. The petitioner further
contended that the AAR erred in concluding that the transaction entered
into between the petitioner, Vatika and the JV company was essentially a
loan transaction, disguised as an investment in shares and CCDs. It was
contended that the AAR erred in holding that the corporate veil ought to be
lifted and in proceeding on the basis that Vatika and the JV Company were,
essentially, a single entity. Based on this conclusion, the AAR had held
that the debt owed by the JV company was in reality Vatika's debt and the
amount received by the petitioner in excess of the investment made by the
petitioner would amount to `interest' paid/payable by Vatika for borrowing
funds from the petitioner.
10. The learned counsel appearing for the respondent supported the
decision of the AAR and submitted that the ruling was a reasoned one and
was neither arbitrary nor perverse and thus could not be challenged under
Article 226 of the Constitution of India. It was contended on behalf of the
Revenue that the transaction entered into between Vatika and the petitioner
was essentially in the nature of an External Commercial Borrowing (ECB)
and that was clear from the structure of the SSA and the SHA entered into
by the petitioner, Vatika and the JV company. It was contended that in
terms of the said agreements, the petitioner was entitled to receive a fixed
rate of return and that the duration of the investment would determine the
quantum of return receivable by the petitioner. It was, thus, submitted that
W.P.(C) 1648/2013 Page 5 of 25
the transaction in question must be viewed as a loan transaction and the
returns on the investment were simply interest, liable to be taxed in India.
11. The controversy in the present case revolves around the issue of
whether the gains resulting to the petitioner from sale of CCDs held in the
JV company are taxable as "interest" in its hands.
12. The AAR examined various decisions including the decision of the
Supreme Court in the case of CWT v. Spencer & Co.: (1973) 88 ITR 429
and held that:-
"In view of the facts before us, and the law laid down by the
Hon'ble Supreme Court, we are of the view that the CCD
creates or recognizes the existence of a debt, which remains to
be so till it is repaid or discharged ".
13. There is no dispute as to the nature of Compulsorily Convertible
Debentures. A debenture indisputably creates and recognizes the existence
of a debt and till it is discharged, either by payment or by conversion, the
debenture would essentially represent a debt. A Compulsorily Convertible
Debenture is a debt which is compulsorily liable to be discharged by
conversion into equity. Any amount payable by the issuer of debentures to
its holder would usually be interest in the hands of the holder. Black's Law
Dictionary (7th Edition) defines `interest' inter alia as compensation fixed
by agreement or allowed by law for use or detention of money, or for loss
of money by one who is entitled to its use; especially, the amount owed to a
lender in return for the use of borrowed money. According to Stroud's
Judicial Dictionary of Words and Phrases (5th Edition), interest means, inter
alia, compensation paid by the borrower to the lender for deprivation of the
W.P.(C) 1648/2013 Page 6 of 25
use of his money. Concededly, gains arising from sale of capital assets
would not be in the nature of interest. The expression `interest' as defined
under Section 2(28A) of the Act cannot apply to all gains that are received
by a debenture holder (lender) irrespective of the transaction resulting in
such gains. As an illustration, a lender may assign its debt to a third party
and if such debt is held as a capital asset, the gain or loss arising from the
transaction would be a capital gain/loss in the hands of a lender and would
not be construed as interest. Similarly, any loss suffered by the lender in
such transaction i.e. where a debt is assigned for a consideration less than
the amount lent, would be a capital loss. Whether a Compulsorily
Convertible Debenture is a loan simplicitor or whether it is in the nature of
equity, is not material in determining whether the gain on the sale of the
debentures by its holder is a capital gain or not. This depends entirely on
whether the debentures are capital assets in the hands of its holder.
14. First of all, it is necessary to consider whether the investment - CCDs
and/or the equity shares of the JV company - held by the petitioner, were
capital assets in its hands. In the present facts, the petitioner has asserted
that both equity and the CCDs it subscribed to were capital assets in its
hands. This has also not been disputed by the Revenue before us. Although
the written comments filed on behalf of the Revenue before the AAR stated
that the gains received by the petitioner were business income, apparently
that contention was not pressed and the AAR also did not refer to this
contention. The principal dispute between the petitioner and the Revenue is
whether the gains arising in the hands of the petitioner from transfer of its
investments in the JV Company is `interest' or `capital gains'.
W.P.(C) 1648/2013 Page 7 of 25
15. Under normal circumstances, it is undeniable that gains arising from
transfer of a debenture, which is a capital asset in the hands of the
transferor, in favour of a third party, would be capital gains and not interest.
In other words, if a debenture (which is a capital asset) is transferred by a
holder to a third party, the gains that arise i.e. difference between the costs
of purchase and the sale consideration would be capital gains in the hands
of a transferor. The dispute in the present case arises only because it has
been held that the transaction between the petitioner and the Vatika is a
sham transaction and is essentially a transaction of loan to Vatika which has
been camouflaged as an investment in shares and CCDs of the JV
company.
16. The substratal controversy that needs to be addressed in the present
petition is whether the AAR was correct in holding that the corporate veil
ought to be lifted and that the JV Company and Vatika were essentially the
same entity. And consequently, the amount paid/payable by Vatika in
excess of the amount invested by the petitioner would be `interest' within
the meaning of Section 2(28A) of the Act and Article 11 of the DTAA
between India and Mauritius.
17. Before proceeding further it is necessary to note certain facts. On
04.07.2007, the JV Company was incorporated as a wholly owned
subsidiary of Vatika. At the material time of incorporation the authorised,
issued and paid up equity capital of the JV Company was `1,00,000/-
(Rupee one lac). Vatika was the owner of a tract of land which was
proposed to be developed as a cyber park. In order to garner the investment
in this project, the JV Company and Vatika entered into two agreements
W.P.(C) 1648/2013 Page 8 of 25
with the petitioner namely the SSA and the SHA on 11.08.2007. The SSA
contemplated that a development agreement would be entered into between
Vatika and the JV Company, whereby the development rights in respect of
the project would be transferred by Vatika to the JV Company.
Subsequently, on 06.11.2007, a Development Rights Agreement was
entered into between Vatika and the JV Company in terms of which Vatika
transferred the exclusive and unconditional development rights of the entire
Land to the JV Company. This entitled the JV Company or its authorised
representatives to enter upon the Land and carry out development and/or
improvement at its sole discretion, subject to the applicable laws. The
project constituted of three buildings, and the ownership rights including
the rights of transfer and hypothetication of any asset developed by the JV
Company on the Land (except one building which was excluded), were
vested exclusively with the JV Company. The physical possession of the
Land for the purpose of development was also agreed to be handed over to
the JV Company. In terms of the said agreement, the JV Company was
exclusively entitled to all proceeds from the commercialisation, sale,
transfer, lease or disposal in any other manner of the project, the buildings
(except the excluded building) or any part thereof. Essentially, the real
estate project on the land in question now vested with the JV Company.
18. The terms of participation of the petitioner in the JV Company and,
consequently, in the project were recorded in two separate agreements
entered into on 11.08.2007 namely the SSA and the SHA. Under the SSA,
it was contemplated that in the first instance (i.e. the First Closing Date)
authorised share capital of the JV Company would be increased and Vatika
W.P.(C) 1648/2013 Page 9 of 25
would subscribe to 76,000 equity shares for an aggregate consideration of
`7,60,000/-. The petitioner would also make its first tranche of investment
in the JV company and be allotted 7350 equity shares of `10 each and
209,926,500 CCDs of `1 each. The petitioner would also subscribe to the
shares and Compulsorily Convertible Debentures in 3 additional tranches.
In aggregate, the petitioner would invest `100 crores and be allotted 46,307
equity shares, and 88,25,85,590 zero percent CCDs having a face value of
`1.
19. The terms and conditions of the issue of CCDs were specified in
schedule III to the SHA. The CCDs were compulsorily convertible into
equity shares after expiry of 72 months from the date of the first closing
(i.e. the date when the first tranche of investment was made by the
petitioner). In addition, the CCDs were also convertible prior to 72 months
at the option of the petitioner. On the expiry of 42 months from the First
Closing Date, the petitioner was entitled to require the JV Company to
convert 33,485,494 CCDs into equity shares. The petitioner was entitled to
conversion of 37,526,847 CCDs, 42,346,809 CCDs and 48,159,116 CCDs
after expiry of 48 months, 54 months and 60 months respectively. The
SHA also recorded the agreement between the petitioner, Vatika and the JV
Company with regard to the management of the JV Company.
20. The AAR has concluded that the entire transaction which is
embodied in the SSA, SHA and other documents is a sham and the real
transaction is only of the petitioner granting a loan to Vatika. The AAR
arrived at the conclusion essentially on the following findings:-
W.P.(C) 1648/2013 Page 10 of 25
(a) That the SHA specified a fixed rate of return on the investment
made by the petitioner.
(b) That the Board of Directors of the JV Company was not in
control of its affairs which were managed by Vatika/its
shareholders.
(c) That the entire transaction was structured as a investment into
equity and CCDs to avoid the incidence of tax.
21. The AAR concluded that the agreements entered into (the SHA and
the SSA) recorded the agreement that the petitioner would receive a fixed
rate of return. For this purpose, the AAR relied upon Article 10 of the SHA
which contained the covenants with regard to the call and put options. It
would be, thus, necessary to refer to the relevant clauses which are quoted
below for ready reference:-
"10. CALL AND PUT OPTION
10.1 Vatika Call Option
(a) In consideration of the mutual covenants of Vatika and
the Investor contained herein, the Investor hereby
grants to Vatika an option (the "Call Option") to
acquire all, but not less than all, the Investor Securities
(the "Call Option Securities") during the Call Period.
(b) The purchase price of the Call Option Securities (the
"Call Option Purchase Price"):
(i) if the Call Option is exercised on or prior to the
expiry of the third anniversary of the First
Closing Date, shall be the sum of (I) the Investor
Investment Amount (less any Bought Back
W.P.(C) 1648/2013 Page 11 of 25
Subscription Amount); (II) the amount equal to
the Accrued Return till the Completion Date; (III)
the Equity Payment; and (IV) an amount equal to
8% per annum of the Investor Investment Amount
(less any Bought Back Subscription Amount)
calculated from the second anniversary of the
First Closing Date till the Completion Date, less
the Vatika Return, if any;
(ii) if the Call Option is exercised after the expiry of
the third anniversary of the First Closing Date,
shall be the sum of (I) the Investor Subscription
Amount (less any Bought Back Subscription
Amount); (II) the amount equal to the Accrued
Return till the Completion Date; and (III) the
Equity Payment, less the Vatika Return, if any.
xxxx xxxx xxxx xxxx xxxx
10.2 Investor Put Option
(a) In consideration of the mutual covenants of Vatika and
the Investor contained herein, Vatika hereby grants to
the Investor an option (the "Put Option"), exercisable
at any time on or subsequent to the fifth anniversary of
the First Closing Date or in the event of a Material
Default by the Company or Vatika which default has
not been remedied or cured within thirty (30) days of
notice of such default by the Investor, to sell to Vatika,
all the Investor Securities ("Put Option Securities")
and upon exercise of the Put Option, Vatika shall be
obliged to purchase the Put Option Securities at the
Put Option Purchase Price (as defined hereinafter).
(b) The purchase price of the Put Option Securities (the
"Put Option Purchase Price") shall be the sum of (I)
the Investor Subscription Amount (less any Bought
Back Subscription Amount); (II) the amount equal to
the Accrued Return till the Completion Date; and (III)
the Equity Payment, less the Vatika Return, if any."
W.P.(C) 1648/2013 Page 12 of 25
22. In our opinion, the aforesaid clauses cannot be read to mean that the
petitioner was only entitled to a fixed return on the investments made by it
in the equity and CCDs issued by the JV company. Article 10(1) of the
SHA entitles Vatika to call upon the petitioner to sell its investment at a
price to be computed in the manner as provided in the clause. If the option
is exercised prior to the completion of three years from the First Closing
Date, the petitioner would be entitled to the value of investment plus a fixed
return as is computed in accordance with clause 10.1(b)(i) of the SHA.
However, if this option was exercised after the expiry of three years from
the First Closing Date, the price to be computed would also include a
component of "equity payment" which was defined to mean an amount
equal to 10% of the project value. Thus, if the option was exercised by
Vatika after a period of three years from the First Closing Date, the
petitioner would be entitled to a certain portion of the project value and
consequently, a portion of the assets of the JV Company. Article 10.2 of
the SHA contains a provision whereby the petitioner could call upon Vatika
to purchase its investment. However, this option could only be exercised
by the petitioner after the expiry of five years from the date of first closing.
In the event that the petitioner exercised such option, it would be entitled to
receive the price as computed in accordance with clause 10.2(b) of the
SHA. This price would also include the component of "equity payment"
(i.e. 10% of the project value). However, it is to be noted that Article 10
only provided for options either to Vatika to buy out the stake of the
petitioner in the JV Company, or to the petitioner to exit the JV Company
by calling upon Vatika to buy its shares. It is vital to bear in mind that it
was not necessary that either Vatika or the petitioner exercise the options as
W.P.(C) 1648/2013 Page 13 of 25
available to them. By the very definition, call & put options were only
options that were available to the contracting parties. In the event none of
the options were exercised, the CCDs held by the petitioner would
mandatorily be convertible into equity shares and the petitioner would be
entitled to the benefits that would accrue to an equity shareholder in respect
of the equity shares issued by the JV Company on conversion of the CCDs.
In our view, merely because an investment agreement provides for exit
options to an investor, would not change the nature of the investment made.
It also cannot be ignored that the options were granted to the investor as
well as to Vatika. A plain reading of the SHA indicates that it is essentially
a joint venture agreement and it is common in any joint venture agreement
for the co-venturers to include covenants for buying each-others' stakes.
Although, the SHA enables the petitioner to exit the investment by
receiving a reasonable return on it, and in that sense it is assured of a
minimum return, the same cannot be read to mean that the CCDs were
fixed return instruments, since the petitioner also had the option to continue
with its investment as an equity shareholder of the JV Company.
23. Article 11 of the SHA also provides additional rights to the petitioner
including the right to sell its entire equity in the JV Company to a third
party and recover the value as calculated under clause 11.2(d)(i) of the
SHA. It is also necessary to bear in mind that the rights with regard to
options as well as additional rights under Article 11 of the SHA were the
mutual rights and obligations between Vatika and the petitioner and not the
JV company. The JV Company would in any event, whether the options
W.P.(C) 1648/2013 Page 14 of 25
were exercised inter se Vatika and the petitioner or not, convert the CCDs
into equity shares on completion of 72 months from the First Closing Date.
24. The next issue to be examined is whether the covenants of the SHA
warranted a finding that the JV Company and Vatika were a single entity.
A plain reading of the SHA indicates that the JV Company was to be
managed as a joint venture between the petitioner and Vatika and the JV
Company was not an alter ego of Vatika alone. Some of the relevant
clauses of the SHA are quoted below:-
"4. CORPORATE GOVERNANCE
4.1 Board of Directors
4.1.1 The Company shall have a Board comprising of five (5)
members. Unless otherwise agreed in writing between
the Parties and subject to Article 11.1(a)(ii), the
composition of the Board shall be as follows:
a) three (3) nominee Directors nominated by Vatika;
and
b) two (2) nominee Director(s) of the Investor.
xxxx xxxx xxxx xxxx xxxx
4.5 Board Meetings
4.5.1 Frequency & Location
The Board shall meet at least once every three (3)
months, with each such meeting to be held in the
National Capital Region or such other place as may be
agreed in writing by at least one Investor Director.
4.5.2 Quorum
The quorum for a meeting of the Board shall be as
required under the Act, subject to at least one (1)
Investor Director and (1) Vatika Director being present
at such meeting.
W.P.(C) 1648/2013 Page 15 of 25
xxxx xxxx xxxx xxxx xxxx
4.5.4 Voting
At any Board Meeting, each Director may exercise one
(1) vote Except in respect of Affirmative Vote Items, the
adoption of any resolution of the Board shall require
the affirmative vote of a majority of the Directors
present at a duly constituted Board Meeting. The Board
shall not at any Board Meeting adopt any resolution
covering any matter that is not expressly specified on
the agenda for such Board Meeting unless a majority of
the Directors present at such Board Meeting, which
shall include at least one (1) Investor Director, vote in
favour of such resolution.
xxxx xxxx xxxx xxxx xxxx
4.6 Affirmative Vote Items
4.6.1 Subject only to any additional requirements imposed by
the Act and Articles 4.6.2 and 11.1(b) below, during the
term of this Agreement, neither the Company nor any
Shareholder, Director, officer, committee, committee
member, employee, agent or any of their respective
delegates shall, without the affirmative written consent
or approval of each of the Investor and Vatika whether
in any Board Meeting, meeting of a committee of
Directors, General Meeting, through any resolutions by
circulation or otherwise, with respect to the Company,
take any decisions or actions in relation to any of the
matters set forth in the Schedule-II (the "Affirmative
Vote Items").
xxxx xxxx xxxx xxxx xxxx
4.7 General Meeting
4.7.1 An AGM shall be held each calendar year within three
(3) months following the end of the previous Financial
Year. The Board shall provide the Company's previous
Financial Year's Financial Statements to all
Shareholders at least one (1) month before the AGM is
W.P.(C) 1648/2013 Page 16 of 25
held to approve and adopt the Financial Statements. All
other General Meetings, other than the AGM, shall be
EGMs. The quorum for General Meetings shall be in
accordance with the Act, subject to at least one (1)
authorized representative representing the Investor and
one (1) authorized representative representing Vatika.
4.7.2 Subject to the Act, a minimum twenty one (21) Business
Days prior written notice shall be given to all the
Shareholders of any General Meeting, accompanied by
the agenda for such General Meeting (unless the
Investor and Vatika shall have given written approval
for a meeting called at shorter notice, in accordance
with the provisions of the Act).
xxxx xxxx xxxx xxxx xxxx
4.9 Certain Matters concerning the Project Documents
4.9.1 It is expressly agreed that, unless otherwise agreed by
the Investor, in any Board Meeting the Vatika Directors
shall refrain from participating in any discussion that
concerns the exercise of the Company's rights under
any Project Documents or any transactions
contemplated thereby, and any decision taken by the
Board in such case (even though it may be taken in the
absence of the consent of Vatika or Vatika Directors)
shall validly bind the Company.
4.9.2 Vatika and the Company acknowledge that no decision,
consent, approval or notice given by the Company
under the Project Documents shall be binding on the
Company unless such decision, consent, approval or
notice is previously approved, in writing, by the
Investor or an Investor Director. Further, any notice or
communication given by Vatika to the Company under
the Project Documents shall be deemed to have been
validly served on the Company only if such notice or
communication is also provided to the Investor or an
Investor Director.
W.P.(C) 1648/2013 Page 17 of 25
4.9.3 Nothing in this Article 4.9 shall affect Vatika's ability to
exercise its rights as a party to the Project Documents.
xxxx xxxx xxxx xxxx xxxx
5. STATUTORY AUDITOR AND INTERNAL
AUDITOR
For the Financial Year commencing on the date of
incorporation of the Company and ending March 31,
2008, the statutory auditor of the Company shall be
Ernst & Young. For all subsequent Financial Years, the
Company shall appoint and cause the appointment of
either Ernst & Young or such other reputable firm of
international accountants that is approved in writing by
the Investor as the statutory auditors of the Company.
The Company shall also appoint a reputed accounting
firm acceptable to the Investor as the internal auditor of
the Company.
xxxx xxxx xxxx xxxx xxxx
8. RELATED PARTY TRANSACTIONS
8.1 Vatika and the Company covenant that any related
party transactions entered into by the Company shall be
after full and adequate disclosure of all material
aspects of such transactions and with the consent of the
Investor which consent shall not be unreasonably
withheld and in any event on an arm's-length basis and
in compliance with all requirements of the Act and
subject to procurement of any approvals that maybe
required from any Governmental Authority.
8.2 Vatika and the Company shall ensure that all
transactions with tenants, service providers, customers,
vendors, contractors or the like, that are common
between the Company and Vatika or its Affiliates, shall
be on an arm's length basis.
xxxx xxxx xxxx xxxx xxxx
9.7 Bank Accounts
W.P.(C) 1648/2013 Page 18 of 25
The Company shall, and Vatika shall cause the
Company to open and maintain a bank account or bank
accounts in its own name with such bank or banks as
may be determined by the Board. Such account or
accounts shall be operated as the Board shall resolve
from time to time. All payments to or by the Company
shall be paid into or withdrawn from such account or
accounts. It is agreed that all payments made by the
Company (including any payments under the
Construction Contract) shall be made only after such
payments have been authorized, in writing by the Asset
Manager."
25. Article 4 of the SHA contains clauses with regard to the manner in
which the JV Company would be managed. As per clause 4.1.1, Vatika
was entitled to nominate three directors and the petitioner was entitled to
nominate two directors on the board of the JV Company. Clause 4.5.2 of
the SHA provided that at least one director nominated by the petitioner and
one director nominated by Vatika be present for constituting a valid
quorum. In terms of clause 4.6.1, certain vital matters as specified in
Schedule II of the SHA would require an affirmative vote of both Vatika as
well as the petitioner. A perusal of Schedule II to the SHA indicates that it
included an exhaustive list of matters that may be considered vital in
relation to a company. Thus, by virtue of clause 4.6.1, all decisions that
were considered important required the consent of both the petitioner as
well as Vatika.
26. By virtue of clause 4.9, in certain matters concerning the project
documents (i.e. relating to transfer of development rights by Vatika to the
JV Company), the Directors of Vatika were obliged to refrain from
participating in any discussion. This clause ensured that in certain matters
W.P.(C) 1648/2013 Page 19 of 25
where there was a possibility of a conflict of interest between Vatika and
JV Company, the nominee directors of Vatika would not influence the
decision of the JV Company. Article 8 also recorded that all transactions
with related parties would be conducted on a Arm's Length Basis.
27. A plain reading of the SHA, including the above referred clauses,
clearly indicate that the affairs of the JV Company were to be managed
separately and distinctly from that of Vatika. The reading of the agreement
as a whole clearly indicates that the petitioner was entitled to participate in
the management and affairs of the JV Company, not only by appointing its
nominee directors but also by ensuing independent auditors and an
independent Asset Manager.
28. Since Vatika was also involved in developing the project, clause 9.7
of the SHA ensured that no payments would be made by the JV Company
to Vatika under the Construction Contract without the authority of an
independent Asset Manager which was defined as Westcourt Properties
Private Limited. All the clauses clearly indicate that the affairs of the JV
Company were to be managed independent of Vatika. In view of the above,
we find the conclusion that when the corporate veil of the JV Company is
lifted, Vatika and the JV Company were essentially one and the same entity
to be wholly erroneous and not warranted. In our view, the terms of the
SHA cannot be read to justify this conclusion.
29. Lastly, we must examine the finding that the present agreement has
been structured only for the purposes of avoiding tax. Foreign Direct
Investment (FDI) is permitted in the real estate sector, provided that certain
W.P.(C) 1648/2013 Page 20 of 25
mandatory conditions are met. According to Press Note 2 of 2005 issued by
the Department of Industrial Policy & Promotion, 100% FDI under the
automatic route was allowed for investments in townships, housing, built
up infrastructure and construction-development projects subject to the
guidelines specified therein. The guidelines specified under the Press Note
are quoted below:-
"a. Minimum area to be developed under each project would
be as under:
i. In case of development of serviced housing plots, a
minimum land area of 10 hectares
ii. In case of construction-development projects, a
minimum built-up area of 50,000 sq.mts
iii. In case of a combination project, anyone of the
above two conditions would suffice.
b. The investment would further be subject to the following
conditions:
i. Minimum capitalization of US$10 million for
wholly owned subsidiaries and US$ 5 million for
joint ventures with Indian partners. The funds
would have to be brought in within six months of
commencement of business of the Company.
ii. Original investment cannot be repatriated before a
period of three years from completion of minimum
capitalization. However, the investor may be
permitted to exit earlier with prior approval of the
Government through the FIPB.
c. At least 50% of the project must be developed within a
period of five years from the date of obtaining all
statutory clearances. The investor would not be permitted
to sell undeveloped plots."
30. In terms of the Circular no.74 dated 08.06.2007 issued by the
Reserve Bank of India, an instrument which is fully and mandatorily
W.P.(C) 1648/2013 Page 21 of 25
convertible into equity shares within a specified time would be reckoned as
part of equity under the FDI Policy. The relevant portion of the said circular
is quoted below:-
"2. ....... It is clarified that henceforth, only instruments which
are fully and mandatorily convertible into equity, within a
specified time would be reckoned as part of equity under the
FDI Policy and eligible to be issued to persons resident outside
India under the Foreign Direct Investment Scheme in terms of
Regulation 5 (1) of Foreign Exchange Management (Transfer
and Issue of shares by a Person Resident outside India)
Regulations, 2000 notified vide Notification No. FEMA
20/2000-RB dated May 3, 2000."
31. Thus, in terms of the policy of the Government, the petitioner could
invest in a project of the requisite size/nature and an investment into CCDs
would be reckoned as equity. The policy with regard to external
commercial borrowings had other conditions and it is apparent that the
petitioner found the investment in CCDs as the most appropriate route for
making its investment in real estate, in accordance with the policy of the
Government of India. In these circumstances, it ought not to be readily
inferred that the entire structure of the transaction was designed solely for
the purposes of avoiding tax.
32. It would also be relevant to note that if the gains are considered as
payment of interest by Vatika, as is contended by the Revenue, the same
would also mean that the quantum of interest is a deductable expenditure in
the hands of Vatika. Viewed from this perspective, it would be erroneous to
conclude that the whole transaction had been structured to ensure avoidance
of tax on income.
W.P.(C) 1648/2013 Page 22 of 25
33. The Supreme Court in the case of Vodafone International Holdings
BV v. Union of India and Anr.: (2012) 6 SCC 613 had held that Court
must look at the entire transaction as a whole and not adopt a dissecting
approach. The Supreme Court further held that the court cannot start with
the question of whether the transaction is a tax saving device, but should
instead apply the "look at test" to ascertain its true legal nature. The
relevant extract from the said judgment of the Supreme Court is quoted
below:-
"79. When it comes to taxation of a holding structure, at the
threshold, the burden is on the Revenue to allege and establish
abuse, in the sense of tax avoidance in the creation and/or use
of such structure(s). In the application of a judicial anti-
avoidance rule, the Revenue may invoke the "substance over
form" principle or "piercing the corporate veil" test only after
it is able to establish on the basis of the facts and circumstances
surrounding the transaction that the impugned transaction is a
sham or tax avoidant. To give an example, if a structure is used
for circular trading or round tripping or to pay bribes then such
transactions, though having a legal form, should be discarded
by applying the test of fiscal nullity. Similarly, in a case where
the Revenue finds that in a holding structure an entity which
has no commercial/business substance has been interposed only
to avoid tax then in such cases applying the test of fiscal nullity
it would be open to the Revenue to discard such
interpositioning of that entity. However, this has to be done at
the threshold.
80. In this connection, we may reiterate the "look at" principle
enunciated in Ramsay [1982 AC 300 : (1981) 2 WLR 449 :
(1981) 1 All ER 865 (HL)] in which it was held that the
Revenue or the Court must look at a document or a transaction
in a context to which it properly belongs to. It is the task of the
Revenue/Court to ascertain the legal nature of the transaction
and while doing so it has to look at the entire transaction as a
W.P.(C) 1648/2013 Page 23 of 25
whole and not to adopt a dissecting approach. The Revenue
cannot start with the question as to whether the impugned
transaction is a tax deferment/saving device but that it should
apply the "look at" test to ascertain its true legal nature
[see Craven v. White (Stephen) [1989 AC 398 : (1988) 3 WLR
423 : (1988) 3 All ER 495 (HL)] which further observed that
genuine strategic tax planning has not been abandoned by any
decision of the English Courts till date].
81. Applying the above tests, we are of the view that every
strategic foreign direct investment coming to India, as an
investment destination, should be seen in a holistic manner.
While doing so, the Revenue/courts should keep in mind the
following factors: the concept of participation in investment, the
duration of time during which the holding structure exists; the
period of business operations in India; the generation of
taxable revenues in India; the timing of the exit; the continuity
of business on such exit.
82. In short, the onus will be on the Revenue to identify the
scheme and its dominant purpose. The corporate business
purpose of a transaction is evidence of the fact that the
impugned transaction is not undertaken as a colourable or
artificial device. The stronger the evidence of a device, the
stronger the corporate business purpose must exist to overcome
the evidence of a device."
34. In the present case, there is sufficient commercial reason for the
petitioner to have routed its investment in the real estate project through
equity and CCDs. The pre-mature exit options as recorded in the SHA and
the minimum return assumed by Vatika on its investment are clearly
commercial agreements between the parties. These by itself do not change
the legal nature of the transaction entered into between the parties. The
terms of the arrangements between Vatika and the petitioner reveal that the
JV was a genuine commercial venture, in which both partners had
W.P.(C) 1648/2013 Page 24 of 25
management rights. The call and put options were defined commercial
options capable of being elected by the parties. In our opinion, there is,
thus, no reason to ignore the legal nature of the instrument of a
Compulsorily Convertible Debenture or to lift the corporate veil to treat the
JV Company and Vatika as a single entity.
35. In view of the above, the writ petition is allowed and the impugned
ruling is set aside.
36. CM No. 3105/2013 seeking stay of the order of the AAR is disposed
of accordingly.
37. The parties are left to bear their own costs.
VIBHU BAKHRU, J
S. RAVINDRA BHAT, J
JULY 30, 2014
RK/MK
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